“Is a Startup Ecosystem Without Lawyers a Good Thing or a Bad Thing?”

In our recent discussion on his blog about the appropriate cost of legal documents for startups (which he argues is zero), Bill Carleton posed an interesting question about the role of lawyers in the early lives of startups.

Bill reasons in his post that startups are in a somewhat unique situation — at least compared to businesses in other contexts requiring legal services, such as acquisitions — because their legal needs are standard. According to Bill, “[E]ntrepreneurs do not want the relevant legal documents – charter, bylaws, stock subscriptions, assignments of invention – to be unique or to feel customized. They want them to read like everyone else’s.”

In fact, this attitude reflects a general “ecosystem of efficiency.” Commenting on the role of lawyers, Bill states that “lawyers need to participate in that ecosystem of efficiency; if they do not, entrepreneurs and the ecosystem will find ways to bypass them.” Then he asks “Is a startup ecosystem without lawyers a good thing or a bad thing?”

By “participate in that ecosystem of efficiency,” I believe Bill is suggesting that we’d better get with the program, begin to reflect the values of our startup clients, and start doing things more efficiently — and less expensively. Otherwise, they’ll vote with their feet and find other means of meeting their needs for legal services.

Startups have already bypassed lawyers

My initial thought is that startups have already largely bypassed lawyers — unfortunately, not by using alternative providers, but by do-it-yourself lawyering. I don’t think that’s a good thing.

In my mind, I divide startups into three categories: nonfundable startups (those that will never be seeking equity funding beyond the proverbial friends, family, and fools), fundable startups (startups whose business plan requires investment by angels and maybe venture capitalists), and high profile startups (fundable startups whose founders are stars in the national startup community and who expect to attract funding from high profile venture capitalists).

I’d be shocked to learn that more than a tiny fraction of nonfundable startups seek legal help at all when they set up their companies. LegalZoom claims to have been a part of the formation of more than 20% of California LLCs during the last ten years. Most nonfundable startups that don’t use services like LegalZoom prepare their documents themselves or have non-lawyers such as CPAs do it. By and large, lawyers don’t care about these companies because they represent very little fee potential. I think that’s unfortunate, partly because the legal needs of nonfundable startups are as real as the needs of other startups, but more selfishly because they represent a huge potential market that we’re almost completely ignoring.

On the other end of the spectrum, high profile startups have their legal needs met by large law firms and high profile startup lawyers. These companies don’t have to worry so much about the cost of legal fees because they can often get their work done for free or at a deep discount as a loss leader in the expectation for well-paying work as the companies’ founders go through the arc of raising money, building the business, and eventually exiting. Or they can defer payment of legal fees until they have money. Or they can pay their lawyers with equity. Whatever the structure, high profile startups can get help from high profile lawyers because they have money — either in hand or on the way.

Lawyers should be a part of the ecosystem, but not a large part

I think Bill had the run-of-the-mill fundable startup in mind when he spoke of an ecosystem of efficiency. I think we should be a part of the early lives of companies because we are valuable aids in helping business people think through their business and legal situation to come up with a prudent course of action. Our perspective is unique and valuable as we view issues through the lens of the law and consider the legal relationships that are involved. In my experience that “partnership” between business person and lawyer is very valuable, and it’s obviously not possible when the lawyer is excluded.

Although lawyers are valuable, there’s a lot of work we do that could be done better by someone else. Of all the people in a law firm who provide services to business clients, lawyers are invariably the highest-cost providers. Paralegals, administrative assistants, IT folks, and vendors are all less expensive than lawyers. And there are vendors that can do things traditionally done by law firms faster, better, and less expensively than lawyers do, and they can be engaged directly by companies without having to go through a law firm. Plus, there’s an amazing amount of information about the law available for free on the internet, so companies don’t necessarily need their lawyer to write a memo about a legal issue — a link or two to relevant content on the web might be better, and it would certainly be less expensive.

So while I think lawyers should be a part of the startup ecosystem, we need to re-think what our role is and strive to do a better job of meeting the needs of startups in terms of the services we provide, how we provide them, and the cost. Whatever that role is, it should involve fewer lawyer-performed tasks than it has in the past.

(1) defining what the role of the lawyer in the startup ecosystem is or ought to be by asking for the voice of the customer;

(2) identify what the voice of the customer perceives as its legal needs and compare those perceptions to what lawyers perceive the legal needs are;

(3) once the role of the lawyer in the startup ecosystem is defined and the actual legal needs are identified then both the lawyers and the startups should scrub the business process currently used to meet those needs in order to produce an improved process which by definition would meet the needs of startups, fix the process by which lawyers meet those needs and address the cost issue.

Bradley: What are you an engineer or something? Careful, or no one will believe you know how to fly by the seat of your pants like a real lawyer.

It probably sounds crazy, but my initial thought is that it might be difficult to locate the voice of the customer. We could ask our current clients, but they might not represent the thoughts of unrepresented startups. Maybe surveying non-clients would be helpful. Maybe someone’s already done that … ?

My second thought is that it would be very interesting to compare what we think startups need and what they think they need. It would be eye-opening indeed.

Do you have a sense of how a new process would differ from current processes?

Brian: The interwebs are replete with self-described “experts” who claim they know what the solutions are but they offer nothing in the way of how to actually accomplish the task. For example, there are a plethora of claims that legal project management is a great way to improve the process but hardly a single font is spilled to show how to actually apply project management principles to the practice of law.

We can compose a survey (using crowdsourcing of course!) and get it in front of entrepreneurs at SXSW, upcoming hackathons and online startup communities and forums. Using social media we can reach out to the startup world and invite participation. Our current clients could be asked why they hired a lawyer in order to compare their responses to those who chose not to hire a lawyer. I believe the critical piece of knowledge in all of this–because I believe it reveals the right solution is the data comparing founders’ perceptions with lawyers’ perceptions.

Perhaps your next post should lay out a typical entity formation process and invite comments on process improvement. For example, in Texas the typical entity formation process might look something like this: (1) client engages lawyer; (2) lawyer advises client on choice of entity and the benefits and risks of each choice; (3) client makes a choice based on the advice of both the lawyer and the client’s CPA; (4) lawyer procures the necessary information to draft the initial formation documents; (5) lawyer prepares drafts of the initial formation documents; (6) client reviews the initial drafts; (7) lawyer revises the initial formation documents and prepares final execution copies; (8) client executes final formation documents; (9) lawyer files final formation documents; and (10) the Secretary of State issues a certificate approving the formation of the new entity.

There are a number of twists and turns in this process that I’m certain I’ve neglected to mention but I think this process would suffice for discussion purposes. Some commentators may share their best practices for improving this process. Others might propose particular technology which is in existence that would improve one or more steps in the process. Some might have ideas on technology that could be developed to improve one or more steps in the process while others might have ideas on how existing technology could be improved.

I’ve often thought that the use of very creative and short videos (like the whiteboard videos that go viral on the internet) explaining the differences between entity choices is one way to improve the process. The result is using technology to effectively automate part of the general advice part of the process.

Bradley: This is good stuff. I’m mulling it over, but a quick note: you’ve hit on something important with your comment about the whiteboard videos — education is an important part of the equation. Organizing, externalizing, and automating the communication of the general information that we routinely provide our clients would make the process more efficient and more effective.

Education efforts should also focus on educating lawyers. I don’t think people are trained properly, as a general rule.

I once spoke with a lawyer who had 15 small to mid-size private companies that he represented each for the same monthly retainer. He was their outside general counsel and had been for many, many years. Other companies wanted to hire him but he refused to add to his client list. He had no fear that they would monopolize his time and they didn’t. He attributed this to the fact that he was able to cull his client list in the initial years until he had the right fit and the right number. Additionally, he sat down with each client once a quarter and they reviewed all upcoming known legal needs and potential legal needs. If there was a need out of the ordinary they were able to negotiate a price for providing the service. Expectations were very well managed. True knowledge-based relationships were established and cultivated. My point is this: whether this lawyer had a streamlined process, document assembly software or used non-lawyers to complete certain tasks didn’t matter to his clients. They appreciated the value that he provided and the certainty and consistency of their legal spend. This process is a win-win in my opinion, avoids the entire debate discussed herein and is probably many transactional lawyers’ ideal practice.

Bradley: I have that sort of arrangement in my practice — although far too little — and it’s the most rewarding work I do. My dream would probably be to increase the number of that sort of client relationships while utilizing improved tools and processes to provide more for less. The most important thing I do is think and talk, and I’d like to do more of it.

A question I ponder is whether that sort of practice will be possible — or even desirable from a client’s point of view — in the future.

Brian: I’m currently reading “Business Model Generation” which is forcing me to take a long, hard look at the current and future business models for law firms and lawyers. Have you read it? Perhaps we should get a group together in a Google Hangout and play a game with the Business Model Canvas Poster.

If the task is a simple company formation, my advice to clients is often to use a company formation agent such as Jordans to provide the paperwork and process it for a fixed fee. That is usually more efficient than us doing it. Jordans is the market leader, employs a few in-house lawyers, and provides generally good paperwork (I get no commission for saying this!). See http://www.jordans.co.uk/company-formation/ I steer clients away from cheaper alternatives that don’t provide such good paperwork.

In my experience the time-consuming bit of company formation is when there are several founders who need a shareholders agreement, service agreements, etc, particularly if they are inexperienced and need some schooling on what the issues are. If all the client wants is a template shareholders agreement, I can provide that to them without charge, provided they are giving me some other work.

I suspect Bill’s comments relate to a slightly more sophisticated arrangement, eg where an outside investor is involved. Then we start to get more complexity, unless the investor can be persuaded to use a standard document and give strong instructions to their lawyer not to waste time in tweaking etc. Unfortunately, in my experience, many investors are either too inexperienced to give such strong and clear instructions, or aren’t really buying into the “keep it very simple and standard” approach and want their own bells and whistles.

I think we need to have an agreed set of facts against which to debate – what is the business, what scale is it on, what is the transaction for which legal documents are required, what “add on” legal services, eg explanation, negotiation, adaptation of a template, etc are required.

Mark: If I understand correctly what Jordans does, companies like that are a dream of mine … but as far as I know, they don’t exist in the U.S., nor are they allowed to. I’ve thought out loud about why this is so in a Quora answer to the question “Why are lawyers so expensive even with the excess supply of lawyers?” and my thoughts largely center on ethics rules and laws regulating the practice of law.

Your point about having an agreed set of facts is well taken, as there’s quite a range of possibilities.

I think nonfundable startups would largely fall within the category of companies you’d send to Jordans. High profile startups would likely have complex issues that require a high degree of bespoke services, but I’m not too concerned about them both because they’re unlikely to find me attractive unless I re-affiliate with a large firm and because they’re doing fine the way things now stand.

That leaves the run-of-the mill fundable startup, and I agree that their legal needs vary from company to company.

Although there is probably a need for bespoke legal services in every startup situation (I would include even a conversation with a lawyer that goes beyond gathering basic information as bespoke), what I envision is pushing back the point at which bespoke is necessary, as well as the extent to which it is necessary. That would involve standardizing what can be standardized, automating what can be automated, and generally having tasks done by non-lawyers to the extent possible. I think that would result in higher quality services, a lower cost, and faster service.

Jordan’s and their competitors started as formers and resellers of “off the shelf” companies, for people who couldn’t wait the time it took to get a company registered. Nowadays Companies House offers a same-day service, so this rationale has largely disappeared, but they have built up a business offering efficient company formation services. UK laws protecting lawyers focus on protected activities, and company formation was never one of these.

Apparently, US lawyers are better at protecting our turf! And Missouri is better than average among the states. Our “unauthorized practice of law” statute states that “No person shall engage in the practice of law or do law business” unless they are licensed. “Law business” in particular is defined rather broadly, and includes “advising or counseling” about legal matters as well as “drawing … any paper, document or instrument affecting or relating to secular rights.” That latter part tripped up LegalZoom in Missouri and resulted in the recent settlement of a class action lawsuit.

And now, in the name of political correctness, we can set up law firms with non-lawyer investors – sometimes called Tesco law, after the UK supermarket of that name – a road that the ABA has not, so far, been tempted to follow.

The lawyer also needs to be extremely cost-conscious and creative in postponing more costly legal services until the company obtains more financing and/or more information about whether the concept behind the startup is actually viable. Examples of this may include the use of provisional patenting, the leveraging of common documents and the use of pre-incorporation agreements until after proof-of-concept activities have been successful.

Many entrepreneurs are familiar with the advantages of launching with a “minimum viable product,” and similarly many of them would benefit by working with lawyers that are skilled at providing startups with “minimum viable legal protection” in order to preserve the limited dollars of a typical startup. Some lawyers will vehemently disagree with this approach, but I would bet most of them have not recently been (successful) entrepreneurs.